Massimo Derchi is CEO of ERG Renew, the renewable energy branch of ERG, a major Italian petroleum and energy corporation and Director of LukErg Renew, a joint venture between ERG Renew and LUKoil, the leading Russian oil producer.
After graduating in electrical engineering in 1986, Mr. Derchi began his career in the telecommunications industry and then joined the engineering branch of ERG in 1988, where he held the position of Project Manager for international projects. After eight years, he moved to Air Liquide Italia in 1996, as Director of Projects, responsible for realizing two of the largest Oxygen plants ever built by L’Air Liquide.
From 1999 to 2004 Massimo Derchi served as General Manager of the Italian Hamon subsidiary, followed by a position as Managing Director of Balcke Marley Italia.
After returning to ERG in 2005, Mr. Derchitook charge of strategic refining projects, later becoming Head of Procurement for the whole Group and then Head of Planning, Programming and Control of refining business, ultimately progressing to Head of Refining as well as Member of the ISAB Board.
The recent growth of the renewable energy sector in the European Union has been fueled by a wave of favorable legislation in the individual countries. The wind power generation market has profited in particular from national incentive systems (ranging from feed-in tariffs to green certificates). This is demonstrated by the significant increase in “wind farm” installations across Europe over the past five years, and specifically in Italy, where a well structured incentive system has facilitated growth of up to 900 MW installed capacity per annum and the corresponding entrance of many different operators into the market.
This example is also reflected in the strong growth experienced throughout other European nations (around 900 MW per year during the last 5 years), driven by supportive systems in Germany, Spain, UK and France.
The current system set up by the Italian government, which will apply for all wind parks commissioned by the end of 2012, is based on the assignment of a “Green Certificate” for every MWh produced. The value of this certificate is then added to the PUN (Unique National Price), this being the standard national price set by the market for every MW introduced into the grid by energy producers. The result of this system is an attractive final selling price which is currently around 155 €/MWh. However, the system goes even further to protect operators. The green certificate incentive is backed up by two other powerful components making this market an inviting place for many players:
When we consider these three elements, it is easy to understand how financial institutions have been encouraged in recent times to grant operators willing to invest in new plants more credit, thereby creating an opportunity for small operators to enter the market. Despite recent M&A operations, this has still left the Italian market in a highly fragmented state.
So how has ERG Renew used this launching pad of government support to drive its growth strategy in the wind power generation market?
The initial step was taken in 2007 with the acquisition of Enertad (a wind farm operator with approx 80MW installed capacity). This allowed the company to consolidate its position (the ERG Renew business unit was able to reach 120MW and establish itself as a recognized player in the market) and provided an opportunity to exploit the pipeline of projects which Enertad already had awaiting authorization, promising an additional and decisive boost to ERG Renew growth. However, as the planned projects were not authorized to the extent and in the time frame expected, ERG Renew decided to pursue its fast growth strategy by leveraging additional acquisitions. In 2008 the firm acquired new farms in France (for 55MW) while 2010 marked the purchase of new plants from IVPC (Italian Vento Power Corporation) for a total installed capacity of 210 MW.
These operations and the installation of an additional 130 MW through an internal development process has enabled ERG Renew to raise its capacity from 120MW to 510MW in only a few years, with total assets also increasing dramatically in value. As Mr. Derchi, ERG Renew CEO, reports:“besides the challenge to keep growing in order to meet our strategic goals, we are having a hard time shifting from the corporate and management culture of a small company to an industrial scale business operation. This means not only that we have to change the management mind set, but also that we need to adapt our operations and maintenance practices, develop new processes and procedures, so that we are able to monitor our performance faster and better and quickly identify any opportunity to increase our asset value for our shareholders.”
The firm is currently undergoing an internal path of change, aimed at structuring its key business processes to face the complexities that such rapid growth entails. Operations processes such as maintenance and performance monitoring have been fundamentally redesigned to increase autonomy from third contractors and speed up internal capability to identify and correct errors in the way wind farms are operated.
Despite the admirable growth to date, ERG Renew and other Italian operators will find it increasingly difficult to flourish when the national regulators use their influence to shape activity on the markets. Some companies could become highly vulnerable if these state incentives and motivating mechanisms fall away in the short term. Indeed, the Italian government has already proposed a new price setting mechanism that will probably apply to all wind farms starting operations from 2013. Based on the Government proposal, this new system will use a “tender” mechanism in which operators wanting to establish a new farm will have to “bid” for their energy price (which will become the unique price at which they will sell energy to the grid).
This type of system, which is being discussed within a “Unified Conference” and which has also been commented on recently by the European Union, is intended to reduce the total energy selling price, thereby aligning it more to the real cost of production.
An air of insecurity is sweeping through the industry, as diverse players, from developers, manufacturers to operators, are worried about how their currently attractive margins with relatively low competition will survive in the potentially difficult market conditions which may come. As Mr. Derchi explains, “In the past many constructors, developers and public administrations have profited considerably, especially from easy access to credit. As margins reduce, the entire value chain will be forced to adapt to the changing conditions and most probably to a different profitability. The trend is already showing and we can see both developers and turbine manufacturers beginning to reduce prices and shift focus. On one side, major global manu-factures are working hard to improve machine performance as the competition from the east approaches while, on the other side they are gradually shifting their source of revenue from turbine sales to operations and maintenance.”
How the market will really evolve is a tough question to answer as it is impossible to predict the key factors, “Future incentive levels are difficult to forecast. It is also important to realize that such uncertainty will inevitably impact on financing costs and the reduced appetite for risk felt by financial institutions. Incentives and credit are the two key variables at this time.”
In this landscape, it seems reasonable to predict that the market will inevitably experience further consolidation of key operators, these being the only ones continuing to invest together with financial players willing to diversify their portfolio. As Mr. Derchi confirms, “We are likely to see an increase of M&A operations for wind farms in the near future. This is caused by:
As Italy has just initiated a period of significant reforms in almost all economic sectors, the same risks currently arising for the wind power generation market are also emerging for other fields.
When asked which renewable energies have the most potential for growth, Mr. Derchi expressed the following opinion, “I see even greater risks for other sectors such as photovoltaic. The biomass market is probably the most interesting at the moment but its growth will depend greatly on how operators in those sectors will be able to cope with feedstock management. It will be critical for these operators to gain control of the entire value chain….”
So if the national market no longer provides the ideal conditions for new growth, operators have begun to pay more attention to how international regulations across Europe are evolving, as they search for new opportunities.
While Western European countries do not seem to favor additional growth (countries like France and Spain have already experienced the end of the attractive “incentives” period), Eastern Europe currently represents a region in which installation of wind farms can still be a highly attractive business.
This is one reason why Mr. Derchi, as ERG Renew CEO, is keen to stress his company’s example of a partnership with the Russian Lukoil corporation (LukErg), in an aim to expand wind power generation eastwards, “The new frontier for European operators is the Eastern Europe nations. The biggest challenge in those countries is the complexity of the authorization processes.
Bureaucracy is different there and we must realize that national governments there cannot be expected to grant the same guarantees we have experienced in Italy. There are huge opportunities for expansion but we really need to carefully evaluate the country risk.”
Mr. Derchi continues to explain that “…entry strategies need to be tailored country by country. It is important to assess potential regulative scenarios, national energy strategies, number of projects really authorized, etc.... This makes it very difficult to decide the kind of position to take. We have already purchased a 40 WM operating wind park in Bulgaria and are now assessing several opportunities for buying “ready to build” projects in Romania.”
Despite such variables, many players (such as EDP, Enel, Verbund, Iberdrola, Mitsubishi Industrial Holding) have already launched their expansion to eastern countries, branching out into Romania, Poland and Bulgaria, with installed capacity expected to grow on average from 300 to 500 MW per year.
The changes in the incentive systems and a foreseeable reduction of credit availability will very likely drive reduction in the new installation growth rate. Market leaders’ approach will probably shift progressively towards a “more industrial way” of managing the business.
In the Italian market, as with other mature markets in Europe, the reduction of margins will force many players to make cost-effective decisions on capital expenditures (exploring Chinese productions, optimizing construction processes and strategies) and to become more and more efficient in managing operations and maintenance activities (activities internalization, outsourcing strategy re-definition, etc.).
Obviously this will affect margins across the value chain for many operators in the industry. Now is the time for manufacturers, developers and even O&M services providers to adapt their business models to guarantee themselves good levels of profitability.
The emerging markets pose significant country risks although the opportunities are attractive. We will probably see only the more advanced and industrial-scale operators striding out into these regions, as they have the ability to accurately evaluate market information and the means to enter the market there. Small and medium operators will find dealing with complex regulations and the difficult business environment a challenge which is likely to slow down their expansion ambitions.
In conclusion, we can foresee that most relevant operators will focus on consolidation to realize synergies, while also trying to gain a competitive edge by operative practices such as performance and cost control. Some big operators are indeed already exploring alternative ways to manage their operations and maintenance activities and are investing in new systems to improve control and ability to forecast their productions.
By Antonio Liguori, Project Manager, Tefen Italy